Accounting Flow Intuition: BASE Formula - Online Tutor, Practice Problems & Exam Prep

The base formula in accounting is essential for understanding account transactions. It states that the ending balance equals the beginning balance plus additions (like credit sales) minus subtractions (like cash collected). For accounts receivable, this means tracking amounts owed by customers. In retained earnings, the formula incorporates net income and dividends paid. For example, if a company has a beginning balance of $55,000, earns $8,000 in net income, and pays $6,000 in dividends, the ending balance would be $57,000. This formula applies across various accounts, reinforcing the accounting cycle.

BASE Formula: Accounts Receivable

Alright, so now that I've introduced you to the concept of Debits and Credits, I want to show you a simple, but important formula that we use in Accounting. It's going to help us understand how transactions flow through accounts such as cash, inventory, accounts payable, any account. Let's check it out. Alright. So here we go. We've got the formula at the top of the page here and we call it the base formula. Okay? And that's because of the different, the different parts of the formula. Well, they have an acronym base. Okay? So it's our base formula and let's go ahead and go through it right now. So in any account, we're going to have some beginning balance, alright? So if we're talking about cash, well, we're going to have a beginning balance in cash, right? Some amount of cash on hand and then we're going to have additions to the account. When we receive cash, well, our cash balance goes up, right? That's pretty intuitive. And then we're going to subtract from the account. Well, when we spend cash, right? When we have outflows of cash, well that's going to subtract from our cash balance. And then guess what? We're going to be left with an ending balance. Wow. What a revelation, right? We start with some amount, we add things to it, we subtract things from it and then we have ending amount. Great. That's our base formula. It sounds really simple, but you we're going to see how important it is and how each account has different additions, different subtractions. So you want to know for each account how these transactions are going to affect the account with the base formula.

So let's go ahead and go through 2 very common accounts, accounts receivable and retained earnings. Okay? So let's start here with accounts receivable. Remember that accounts receivable, when we see this word receivable, well that means it's an asset, right? Everything receivable is an asset. And accounts receivable specifically, it's amounts that the customers owe to the company, okay? So this is when we sold something to the customer and we said well you can pay us later, okay? We made the sale, but we haven't collected the cash yet. So we have this receivable from the customer, okay? So these are assets. Remember, these are assets right here, okay? So let's go ahead and see how the base formula affects our accounts receivable. Let me scroll down a little bit. So let's start with the beginning balance. Well, what's going to be the beginning balance in accounts receivable? Well, the beginning balance that's money that customers already owe us, right? They owed us from previous periods and they still owe it to us at the beginning of the period. Well that's the beginning balance in the account. And then we're going to add to the accounts receivable. How are we going to increase our accounts receivable? Well that's when we sell more things with IOUs, right? We sell things to the customer and say, hey, you can pay us later. Well that's going to increase our accounts receivable balance, right? So these sales to customers, with IOUs, what we call those on credit, okay? We call them sales on credit or credit sales. That means that we haven't collected the cash yet, but we are expecting to collect it soon, okay? So those are going to be additions to our accounts receivable balance. What about the subtractions? How are we going to lower our accounts receivable balance? So we lower the accounts receivable balance. Well, when we collect cash, right? When the customers who said I'll pay you later, well they finally pay us. When that time comes around, we are going to lower, we're going to lower our accounts receivable balance because we received that cash. Cool? So that's the subtractions from the account and then finally, we have our ending balance, right? Very simple. Beginning balance plus additions, which is more credit sales minus subtractions, which is cash collected from the customers, leaves us with our ending balance, all right? So let's see how this works in an example right here. Let's use our base formula. A company had a beginning balance in accounts receivable of $1200 Throughout the month, the company sold $3,000 in cash and $2,000 on credit. Notice it says 2,000 on credit. The final balance in accounts receivable was $1800. What amount of cash was collected from customers throughout the month? Okay. So we know we collected 3 this month, this month, well there's going to be 3,000 from cash sales, right? That stay on the screen? Nope. Let me go back. Cash sales, right? But there's also the money we collected through accounts receivable, right? We allowed customers to pay us later and some of them did pay us. That's going to be that change in the accounts receivable. Let's check it out. Let's use our base formula. So this is our base formula for accounts receivable, right? Beginning plus addition minus subtractions equals ending balance. So let's use what we just learned about accounts receivable and let's fill in our base formula. So it told us that the beginning balance, right, the B, beginning balance, it told us was $1200 right here, right? $1200 was our beginning balance. So let's put that in right there. What about the additions? How do we add to accounts receivable? Those were the credit sales, right? The credit sales and they told us right here there was 2,000 in credit sales. So that's going to add to our accounts receivable because we haven't received that money yet. We sold it on credit and we're waiting to get paid. How about our subtractions? What's the subtractions from accounts receivable? That's the cash collected. That's what we're looking for in this problem. Right? What what amount of cash was collected from customers? So we're going to leave that. I'll just leave it as the s. Right? Because that's what we're solving for. Let me make a better s. Okay. Actually, I'm gonna put cc for cash collected to be a little more specific, okay? CC stands for cash collected and that's the cash we collected, from accounts receivable, alright? And now let's finish this formula. How about our ending balance? It told us right here, the ending balance was $1800. Right? So look at this, we've got 3 out of the 4 variables in our base formula and this is how it's always going to work. They're always going to have to give you 3 of them. You just have to figure out which 3 they gave you, right? They might not give you the beginning balance, but they'll give you the subtractions or they might not tell you the additions, right? There's always going to be one that's missing and then we have to do a little bit of algebra to solve for the last one. So hope I didn't scare you with that algebra word, but this is really simple algebra. Let's go ahead and do it real quick. 1200 plus 2,000 well, that's 3,200 minus that's our variable the cash collected that we're solving for equals 1800. Okay? So let's just rearrange this a little bit. We'll add cash collected to both sides to get it by itself. Subtract 1800 from both sides. And what are we left with here? We've got 3200 minus 1800, and it's 1400, and then on the other side is our cash collected, what we are solving for. So there we go. 1400 is the cash collected on the account, and that should make sense. Right? If we fill in our entire base formula, let me do it over here. We had our 1200 beginning balance plus 2,000 in credit sales minus 1400 that we actually got paid by the customers equals our ending balance of 1800, right? So the math checks out, we're good. So let's go ahead and finish solving the problem. Most of the time that would just be the answer, but in this one, they were trying to be a little extra tricky by throwing in those cash sales, right? Because at this point, you might have forgot that there were cash sales as well and that's how professors love to trick you. Alright? So we've had those 3,000 in cash sales that was definitely cash collected during the month, but then there was also the 1400, cash from AR. Okay? So that's just a little extra trick. The main thing I want you to notice here was how to use the base formula. Right? So 3,000 plus the 1400 from AR, that's a total of 4,400 in cash collected. And that would be the answer, right? $3,000 in cash sales, $14,000 collected from AR. Cool. So let's go ahead and pause here and let's try using our base formula again with the retained earnings account. Cool? Let's do that now.

BASE Formula: Retained Earnings

Alright. So let's go ahead and use our base formula with retained earnings. So remember that retained earnings, this account, is an equity account, right? This is one of our main equity accounts and it's a holding place for all the income, right? All the income — remember income and earnings, these words are interchangeable. Income and earnings that have not been paid to our stockholders as dividends. So remember, dividends are not an expense, right? Dividends don't go through our income statement. Dividends are literally this money that we've earned over time and then we're giving it to the stockholders who own that money, and stockholders definitely shouldn't have that apostrophe there. So let's go ahead and use our base formula, okay?

We have our beginning balance in retained earnings. Well, this is going to be all the previous year's net incomes, right? We've been storing all this money over time, we've been earning money over time and we haven't paid it all out. Maybe we paid some of it but whatever is left, those are still retained from previous years. And then we've got our additions to the account, right? How are we going to increase our retained earnings? Well, that's by earning more money, right? By having more net income. This year's net income which comes from the income statement, that's the bottom line on our income statement. We have all our revenues, all our expenses, and we're left with our net income. Well, that's going to go to our retained earnings account and then what's going to subtract? Well, that's when we pay those dividends, right? When we pay the dividends to the stockholders' dividends, That's going to subtract from our retained earnings account, and then we're finally left with our ending balance. Boom! Super simple again, right? We've got our base formula. We have some amount of earnings that we haven't paid out, we earn more money so it increases the balance, we subtract when we pay some of it as dividends, and we are left with our ending balance. There is our base formula for retained earnings. So I just want to point out again, remember retained earnings is an equity account. Okay?

So let's go ahead and do an example here. Same as we did above with accounts receivable, let's do the same thing for retained earnings. So the company has a beginning balance in retained earnings of $55,000, so that means in previous years, they had been earning money, they had net income and they had $55,000 that they had not paid as dividends. This year, the company had revenues of $40,000 and expenses of $32,000. The company also declared and paid a dividend of $6,000. What is the final balance in retained earnings?

Okay, so let's go ahead and use our base formula again, right? We've got B plus additions, beginning balance plus additions minus subtractions equals our ending balance, right? So let's take what we do know already. They told us the beginning balance in retained earnings, well, $55,000 that's our beginning balance in retained earnings and then what else? The company had revenues of $40,000 and expenses of $32,000. Let's skip that for now, right? We know we want net income as our additions, let's go to the ones that they gave us straight up. Right here they told us dividends of $6,000, right? $6,000 in dividends, we know the dividends are subtractions from the account, so we're going to have a minus $6,000 here and then what is the final balance is what they're asking us for. So we know that's going to be our variable, right? We're solving for the ending balance, but what about those additions? What are the additions to the account? Net income, right? So how do we find net income? Well on our income statement, we show our revenues, we take out our expenses, and we're left with net income. So in this problem, they didn't tell us specifically our net income, but they told us our revenues and our expenses, right? Let's go ahead and find our net income. We had revenues of $40,000, expenses of $32,000 and well, that leaves us with our net income, right? Revenue minus expenses is net income. So $40,000 minus $32,000 is $8,000. So we know that the additions to the account were $8,000 right here, right? So then since we have $8,000 in net income, well that goes to our retained earnings. That's earnings that we made this year and we haven't paid out, but we did pay some of it, right? We paid $6,000 in dividends and that's going to get us to our ending balance. So $55,000 plus $8,000 minus $6,000, well that's going to be $57,000 right here, right? It goes up by $2,000. So our ending balance right there is $57,000 and that's the answer to this question, right? The little trick that they had here was that you had to solve for net income, right? They didn't just tell you net income, but it's just our base formula nonetheless, right? Beginning balance plus the additions which was this year's net income minus subtractions which was the dividends gets us to our ending balance. Okay?

So you're going to see throughout this course as we go through new topics, you're going to see how the base formula is used for all different types of accounts. We're going to show it for inventory, we're going to see it for accounts payable. Every type of account has this base formula to it. Alright? So let's go ahead, pause here and we'll move on to the next video.

Here’s what students ask on this topic:

What is the BASE formula in accounting?

The BASE formula in accounting is a fundamental equation used to understand how transactions flow through various accounts. It stands for Beginning balance + Additions - Subtractions = Ending balance. This formula helps track the changes in account balances over a period. For example, in accounts receivable, the beginning balance is the amount owed by customers at the start, additions are new credit sales, and subtractions are cash collected from customers. The ending balance is what remains owed at the end of the period. This formula is applicable to many accounts, including cash, inventory, and retained earnings.

How do you apply the BASE formula to accounts receivable?

To apply the BASE formula to accounts receivable, start with the beginning balance, which is the amount customers owe at the start of the period. Add any new credit sales (additions) to this balance. Then, subtract the cash collected from customers (subtractions). The result is the ending balance, which represents the amount still owed by customers at the end of the period. For example, if the beginning balance is $1,200, credit sales are $2,000, and cash collected is $1,400, the ending balance would be $1,800.

How is the BASE formula used in retained earnings?

The BASE formula is used in retained earnings to track the equity account over time. The beginning balance includes all previous years' net incomes that haven't been paid out as dividends. Additions to retained earnings come from the current year's net income. Subtractions are the dividends paid to stockholders. For example, if the beginning balance is $55,000, the net income for the year is $8,000, and dividends paid are $6,000, the ending balance would be $57,000.

What are the components of the BASE formula in accounting?

The components of the BASE formula in accounting are: Beginning balance (B), Additions (A), Subtractions (S), and Ending balance (E). The formula is expressed as: Beginning balance + Additions - Subtractions = Ending balance. Each component represents a different aspect of account transactions. The beginning balance is the initial amount in the account, additions are increases (like credit sales or net income), subtractions are decreases (like cash collected or dividends paid), and the ending balance is the final amount after all transactions.

Can you provide an example of solving for an unknown using the BASE formula?

Sure! Let's solve for the cash collected from customers using the BASE formula for accounts receivable. Suppose the beginning balance is $1,200, credit sales are $2,000, and the ending balance is $1,800. The formula is: Beginning balance + Additions - Subtractions = Ending balance. Plugging in the values: $1,200 + $2,000 - Cash collected = $1,800. Rearrange to solve for cash collected: $3,200 - Cash collected = $1,800. Therefore, Cash collected = $3,200 - $1,800 = $1,400.